The Breakdown - Why a $631B Asset Manager Just Changed Its Mind on Bitcoin

Episode Date: December 2, 2020

Today on the Brief: Libra is now “Diem”  Christine Lagarde comes down on private stablecoins  Dow closes its best month in 33 years  Our main discussion: AllianceBernstein changes its mind.  Yesterday, CoinDesk received access to a private client research report from AllianceBernstein, a global investment giant with more than $631 billion in assets.  In this episode of the Breakdown, NLW reads excerpts from the memo and discusses: Why, in discussing supply, it conflates bitcoin and other cryptos but still finds limited supply “for all practical purposes”  Why prevailing macro political conditions – particularly the growth of government’s role in business and individual lives – shifted the investment firm’s calculus  Why its greatest long-term concern is government banning something that is actively hindering the application of monetary policy

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, nexo.io, and all nodes. And produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, December 1st. And today we're discussing why a $631 billion asset manager just changed their mind on Bitcoin. First up, however, let's do the brief. First on the brief today, Libra is now DM. The journey of Libra has been a wild one from grand ambition and great partners. If you'll remember,

this was going to change the world, bank the unbanked, create a global stable coin backed by a basket of currencies that could serve as a new reserve asset. It had people like PayPal and Visa and Mastercard and eBay involved, and of course it ran headfirst into regulatory reality, and very soon it had slightly smaller ambition and different partners as many of those brand name partners dropped out. Now it's gotten even smaller in its ambition and has even changed its name. Meet DM. The DM Association has 27 members largely from the world of crypto and tech, and they're looking at a 2021 launch of a single dollar-pegged stablecoin. They've also announced a number of new team members.

The big goal of this name change, it seems, is to distance themselves from Facebook. The current CEO of the DM Association, Stuart Levy, argues that regulators are warming up, based in part on moving away from Facebook. Quote, I think regulatory stakeholders really are welcoming a more autonomous association. They want to see an association strong enough to make its own decisions, and have a leadership team that is capable of directing the project. It is in part for that reason we decided to change the name, to move from Libra to Diem, and that will be effective Tuesday.

He reiterated this and reiterated that there was now a new mandate for this project and said, the original name was tied to an earlier iteration of the project that saw a difficult reception from regulators around the world, and we've changed the proposition dramatically. Summing up the shift and prerogative of the association, Frank Chaparro from the block wrote, funny how Libra went from world-changing financial inclusion play to a third-party fintech provider. Next up on the brief today, Christine Lagarde's Stablecoin comments.

Christine Lagarde, the president of the European Central Bank, has been talking about a digital euro a lot, and the TLDR on all of her comments is sort of, it's likely, but it also won't replace cash. They're interested clearly for stimulus and government intervention reasons. However, she clearly has a difference and sees a difference between a government-sanctioned stablecoin and the private model that exists today. On Monday, she published a magazine article in which she said stablecoins could threaten financial security.

Quote, using stablecoins as a store of value could trigger a large shift of bank deposits to stable coins, which may have an impact on banks' operations and the transmission of monetary policy. This is interesting because she is reading correctly that I think in many ways, stable coins are basically Euro-dollar, offshore, non-regulated versions of a fiat currency, and they do, in fact, impact monetary policy. This, of course, is Jeffrey Snyder's whole argument that all of our bluster about the Fed's money canon is wrongheaded, because since the rise of the euro-dollar system and the shadow banking system, we've had very little ability

to even know how much money is out there, much less impact the money supply. Interestingly, Lagarde also came specifically at Libra, saying that stablecoins, quote, particularly those backed by global technology firms could present risks to competitiveness and technology autonomy in Europe. When stable coins are backed by big tech, she said, quote, their dominant positions may harm competition and consumer choice and raise concerns over data privacy and the misuse of personal information. Perhaps that DM switch wasn't so strange after all. Last up on the brief today, the Dow closes its best month in 33 years. Obviously, a ton of our attention has rightly been on Bitcoin punching through all-time highs, only to, of course, roller coaster right on over, which happened

again this morning. But the Dow also had a massive close this month, up 12%, its best since January 1987. The S&P 500 rose 11%, which was the best since April, and NASDAQ was also up 12%. There are, of course, two big causal factors. The first is vaccines. The fact that we are not just seeing promising research and evidence, but we're now in the stage of these vaccine manufacturers actively asking for approval. In fact, right now, a CDC expert panel is preparing its list of recommendations for who gets the first vaccines, and it seems that it's going to be frontline health care workers and nursing home residents on the top of the list. The second causal factor is the increasing smoothness of the Biden transition. This thing is actually happening. There are fewer questions now. And there are a fair

number of known quantities in key economic positions, particularly Janet Yellen as Treasury Secretary, as we discussed last weekend. So while there was a slight dip on Monday, there was another rise today, and the S&P 500 is up 1.2% and on track for another record close. With that, however, let's shift over to our main conversation how a $631 billion asset manager just changed their mind. on Bitcoin. So as I've repeated now a couple times, Alliance Bernstein is a global investment manager with $631 billion in assets. The research arm of that firm just produced a new note for clients. And as you'll see, the firm had previously ruled out Bitcoin as an investment asset in January 2018. But this new note by co-head of the portfolio strategy team at Bernstein Research,

Enigo Fraser Jenkins, starts, I have changed my mind about Bitcoin's role in asset allocation. Today, I thought actually I'm going to switch it up, and instead of just giving you the summary, I'm actually going to read a full or mostly full version of the piece. I think it's that interesting and not worth hearing. So with that, let's dive in. Portfolio Strategy, Cryptocurrencies and asset allocation. I have changed my mind. I have changed my mind about Bitcoin's role in asset allocation.

In January 2018, we declared that it had no such role. But actually, maybe we have to admit it does. What has changed is the policy environment, debt levels, and diversification options for investors post the pandemic. Writing about cryptocurrencies after Bitcoin has staged a large rally in recent weeks, followed by a correction, may inevitably sound like playing catch-up. As a strategist, it is depressingly like upgrading a stock after it reaches a new high. Given the volatility of cryptos, then no doubt over tactical horizons, they can yet

give up more of their recent gains. But this note is aimed firmly at the long-term, not tactical horizons. The pandemic possesses some profound questions for the role of crypto and potentially transforms its role. This note is about two related aspects of crypto. The role of crypto in asset allocation and the way its potential as a medium of exchange affects the ability to implement policy. This is bound up in the questions in power of governments and their likely larger role in economies post-COVID.

This in turn has massive implications for asset allocation. It is relatively easy to create a narrative of why demand for cryptos might increase, given the economic status quo post-COVID. A counteracting force is what is the limit on supply? Bitcoin has a limited supply, but a multitude of cryptos have been created. In theory, total crypto supply is unlimited. However, in this respect, they are like fiat currencies. In practice, only a small number are used for investment. Thus, at any time, the supply of cryptos could be limited for practical purposes, though the exact enumeration of which cryptos are on that list will vary over time. The role of cryptos in asset allocation inevitably leads to a discussion of what is money,

In this light, the pandemic acts as both new force for and against cryptos. On the positive side, there will likely be increased demand as a result of fiscal expansion. The likelihood of inflation, the likelihood that taxes increase, and the change in the debate whereby MMT-related policies are increasingly discussed. In other words, the greater role that governments will likely play in economies makes crypto's potentially more appealing. These very same forces also may hinder cryptos. If they get in the way of policy implementation, then governments might seek to constrain them.

Details. Do cryptocurrencies have a role in asset allocation? When we posed this question in 2018, we concluded that they did not have such a role. We would like to shift that position and say, well, actually, yes, maybe they do. There are a few ways to view this question. Probably easiest is to see this through the narrow lens of an asset allocation problem. We start the note with this, that is the least controversial way to address the problem. In this light, it becomes a purely empirical question and avoids the quasi-philosophical questions of what is money. There has been a market change here since when we declared that Bitcoin had no role in asset allocation three years ago.

These changes have occurred both to the empirical return data of Bitcoin itself and also to the policy framework in which investors operate. With regard to the former, the volatility of Bitcoin has significantly reduced, making it more attractive in its potential twin roles, both as a store of value and as a medium of exchange. Given increases in volatility of other asset classes, this means that the relative volatility of Bitcoin to both gold and equities has declined to historically low levels. However, the pandemic has also seen the correlation of Bitcoin to other major assets rise. The basic issue is that it is a liquid asset, so in times like early March, it can be sold easily and hence does not escape from a rapid

cross-asset deleveraging. The correlation of Bitcoin to other assets has remained high. What does this mean for its role in asset allocation? We will come on to the big picture question later in this note. From a narrow empirical point of view, the downward shift in volatility of Bitcoin makes it more desirable, but its increasing correlation points the other way. The piece then goes on to share a number of different ways to think about optimal asset allocation, which I would suggest you go look at. It's kind of not good for reading. But then we come to the next section that I do want to read. This episode is brought to you by crypto.com, the crypto super app that lets you buy, earn, and spend crypto all in one place and earn up to 8.5% per year on your Bitcoin. Download the crypto.com app now to see the interest rates you could be earning on BTC and more than 20 other coins.

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all nodes.com, the platform preferred by people who make a difference. So visit all nodes.com and use the promo code CoinDesk 3 to get started for free today. Crypto as an inflation hedge. This brings us on to its role as an inflation hedge. This phrase is used somewhat too loosely. Technically, a hedge is something that should move in a way to exactly offset another position. There is no good reason to suspect that a given cryptocurrency should exactly move in a way that would counteract inflation in a given fiat currency. Indeed, apart from a fall in the value of Bitcoin in March, alongside a fall in inflation expectations, for the last five years, the correlation between Bitcoin and inflation expectations has been close to zero. So the issue is

really more a general one of, quote, can cryptos be expected to do well if inflation rises? This is important since we would claim that equities, real estate, and gold are inflation hedges. Related to this is the question of whether it can act as a diversifier as inflation hedges. We've made the case in recent notes that the policy response to the pandemic is, on balance, likely to be inflationary. But we also acknowledge that there are strong deflationary background forces and also the likelihood that unemployment remains very high for an extended period of time. We think that on balance there is an economic argument that the outcome will be inflationary,

though it is really politics that tips the balance in favor of inflation rather than macroeconomics. The likelihood that the velocity of money may decline means that monetary expansion might need to be even greater and puts more emphasis on fiscal policy. In this reading, the driver of Bitcoin is similar to that, as for gold. It is debt levels of major economies having attained the same level at the ends of World War II. There has been declining productivity of debt for decades. This potentially puts semi-permanent upward pressure on debt levels that implies that a greater amount of debt is required to produce a given level of GDP. Granted, the affordability of that debt

is greater now, and in the U.S. at least, this debt has been termed out to greater maturities. But this implies it is hard to reduce the debt stock. In Exhibit 10, we show the index exchange rate of major currencies against gold since 1880. The evidence seems to be that currencies issued by sovereigns face long-term terminal decline against gold either through revolution, war, or growing debt. We note in passing that this ignores the effect of income-paying assets, So, for example, equities denominated in USD would clearly have beaten gold by a huge degree over this time. For crypto bulls, the claim would be that they could potentially fill a similar role as gold in this regard. Central banks, digital currencies, and could cryptos be banned?

Central banks have increasingly discussed the possibility of launching their own digital currencies, so-called central bank digital currencies or CBDCs. There are a range of possible advantages here in terms of payments technologies that are not in the scope of this note. One major innovation, however, would be that it would allow the possibility in theory of imposing negative interest rates. This is hard to do with conventional currency, as at some level of negative interest rates it would lead people to withdraw their money from banks and store it at home. That is not desirable for a number of social reasons, increased crime being one, but it also imposes an effective lower bound on rates that banks can charge retail customers.

If central banks are increasingly exploring such options, what effect would they have on cryptocurrencies? It is not just the potential desire to explore deeply negative rates that could be an issue here. As tax burdens likely rise, including wealth taxes, that may create more demand for cryptos. There have already been examples where changes in government policy have created a demand for cryptocurrencies. One extreme example is in Cyprus, which in 2013 had to impose a drastic levy on bank deposits. We think that the launch of CBDCs could encourage and legitimize the use of digital currencies in general. However, it also points to a problem with cryptos, a property that makes them potentially attractive for asset allocation, i.e. their resistance to being debased in an

attempt to reflate the economy, is actually a possible impediment for them. Were cryptos to be very widely used that they could then seriously hamper an ability for policy to counteract a recession? In a sense, that is part of the point of them. They are not subject to sovereign power. This is what may excite libertarians, but it also raises social questions about whether that's the best result for all. What would Jeremy Bentham think? In crypto's defense, they're at least the most egalitarian of all assets and that they are genuinely open to all to buy, whether or not they have a bank account. It is the core advantage of cryptos that they are outside the bounds of sovereign power when it comes to debasement, taxation, and nationalization. That also raises the question of

what happens if they get in the way of governments implementing policy. Could cryptos be outlawed by governments as gold was in the 1930s? Discussion of this usually revolves around their role in illegal activities. Leaving that to one side, if cryptos caught on so much they hampered a policy attempt to reflate an economy, e.g. through the use of negative rates, then one can imagine a case being made for them to be banned. It is often claimed that they would be hard to out law, given that they are so decentralized, but we don't think that people should underestimate power of governments to rule out activities they don't like. Yes, cryptos might have an advantage in taking out costs, i.e. at least some of the costs that the banking sector charges the rest of the economy. That can help drive their

adoption, though in turn this raises the question of whether disintermediation of banks would imperil the credit creation process. As with the debate about the money supply, there are pros and cons. This would remove costs and could potentially mitigate credit bubbles, but credit creation by private banks is central to how capitalism works. The bottom line is that cryptos get in the way of reflationary policies that could be damaging for the real economy. Of course, cryptos have to be huge for this to have an effect. At the moment, they are tiny in this regard, so the prospect is a long way off. The next section is entitled Bitcoin's Big ESG problem, and I think it's worth reading if you're reading the whole piece, but you've listened to those arguments before.

It basically says that the more the climate conversation increases, the more that Bitcoin could have a target on its back. It also discusses Bitcoin's association with other illegal activities, but these are long-standing arguments. You've heard them before. I think it's important to just keep moving. So with that, let's move to the last section of this pretty extraordinary note. What is money? What is money? All of this inevitably leads back to an almost philosophical question of what actually is money anyway. Montaigne warned us only to philosophize by accident, so this comes at the end of the note and as a result of the discussion of cryptocurrencies as an investment rather than as a precursor to it. Once we move beyond the

narrow empirical questions of the volatility and diversification of a currency such as Bitcoin and what it does in a portfolio from an overall return risk point of view, then the topic quickly touches on a broad set of fundamental issues. Many of those come down to the role of the sovereign state. After COVID, debt levels will be higher, more people will be unemployed and demanding action to address that. Inequality will be greater, which will create social pressures. Governments have become comfortable with allowing large increases in the money supply, and at the same time, they find themselves in possession of new fiscal tools and their ability to hand out cash to individuals in a way that was not deemed acceptable behavior before the pandemic.

All of this is to say that governments are likely to play a bigger role in economies and markets post-COVID. No wonder there is a more intense debate about the concept of modern monetary theory. In fact, one could argue that in a sense that has already become the adopted paradigm, albeit without the institutional trappings of automatic fiscal stabilizers. But we do think that universal basic income is likely in at least one developed economy in the next five to ten years. These issues provoked linked questions about the role of money and also the nature of long-term investment saving. Are cryptocurrencies a form of money in the sense of being a medium of exchange? Or are they a store of value and hence an asset to be used in investment?

Well, they can be both, just as cash denominated in a certain currency can be. We don't think that people need to obsess too much about this question. Both the role of money and the nature of investing are undergoing changes. The world had a relatively small number of currencies for hundreds of years, and now the number of potential currencies has exploded. Indeed, conceptual artist Claudia Sambo and Holly English in a recent work suggested that potatoes could be used as money. After all, the objection that the supply of potatoes could increase massively no longer seems to carry much weight, as a counter-argument to vegetable money in the wake of the Fed creating $3 trillion this year. They also proposed that the value might be tied to their nutritional value,

a nice swipe at the argument in economics at what gives value to tokens used as money. In book five of Nicomachean ethics, Aristotle teaches us, hence all commodities exchanged must be able to be compared in some way. It is to meet this requirement that men have introduced money. It is a measure of how many shoes are equivalent to a house or a given quantity of food. Money then serves as a measure which makes things commensurable. This is the so-called mentalist view of what gives money its value. It essentially is a commodity that is deemed to have inherent value that can replace a barter system.

The other approach to the question of what is money derives more from a view of social interaction. The claim that money really derives from credit and the need to account for it. This view was eloquently laid out in Graber's magisterial history of debt, with a central claim that debt has a long history in human society and the idea of economic exchange starting with bartering is in fact a myth. On this basis, the ultimate basis for the value of a unit of money in today's society is the demand that it is manufactured for it by a government demanding that its taxes be paid in it. The debate between these two views and how it applies to cryptos was very well laid out by Vigna and Casey

2015. They make the case that both schools of thought can be applied to cryptocurrencies. The mentalist view is predicated on the limited supply of cryptos. The latter, or chartless view, is that Bitcoin is a payment system with a new basis for what gives users trust in the system. On this view, it is simply a method for recording and settling debt obligations. What makes it interesting is that there is a new distributed basis of trust, not deriving from a central authority. A concern we've always had is that there is a potential supply problem for cryptos. Yes, Bitcoin famously has a limited supply, but the number of cryptos has no limit. New ones can be created with ease so the overall supply of cryptos can grow. However, perhaps this is not so different than the situation with

established fiat currencies. There are a large number of them, none of which have limited supply, yet in practice, only a relatively small number of them are used for investment purposes. New cryptos can always be created, but if there is no plausible case for their broad adoption, then their extra supply is meaningless. So which ones count as being broadly about? accept it. Bitcoin is clearly at the core of this, and then there are a small group of other ones with reasonably broad acceptance that form an intermediate group, and outside that group, coins don't have a role in investment. This intermediate group will likely evolve over time, and there won't be full agreement as to what coins qualify. But then that is the case for fiat

currencies, too. So is the supply of crypto's limited? Well, technically no, it's not. But for all practical purposes, at any given time, there may indeed be some limits. So much for supply. What about demand? A post-pandemic wave of inflation could potentially, create significant demand for alternative currencies for all the reasons we have discussed here. But while there might be increased demand for cryptos in general, that is no good if one holds the wrong crypto. As we showed earlier in this note, not all cryptocurrencies moved together, and indeed their mutual correlation has fallen recently. The increased demand is only useful if it is for the specific cryptocurrency that one holds. Here there is a fundamental linkage between other currencies

and sovereignty. Either money is said to be worth something because the token being used has its own inherent worth, or else demand for money in question has to be created. One popular way to think of that is governments and their sovereign ability to impose taxes and determine how these should be paid. Thus, governments can always create a demand for their currency by saying that taxes have to be paid in it. Such support is generally speaking absent for Bitcoin, Pay-Zug, which has announced that citizens will be able to pay taxes there in Bitcoin from 2021. In future, one could imagine tax havens or quasi-failed states without well-established currencies as possibly allowing payment in Bitcoin or another cryptocurrency. But it is hard to imagine a major development of the

nation allowing that. It would undercut sovereignty too much. Thus, there is not likely to be a guaranteed backstop of demand. The future of cryptos is bound up with the nature of sovereignty, how this interacts with personal liberty and the major policy decisions that sovereign governments make to steer their economy. To the extent to which the pandemic has accelerated shifts that were already underway and also brought about changes in these domains, then it has also changed the potential role of cryptocurrencies. In the wake of the pandemic, governments likely become more powerful relative to corporations and individuals. Governments probably feel they have earned this right given the extent to which their intervention was necessary to offset the economic impact of

lockdown, though, of course, those lockdowns were imposed by governments too. We need to get used to a greater role of governments in the economy, e.g. through the decision to extend or not direct fiscal measures such as furlough schemes, decisions about whether or not there will be allowed to be a genuine bankruptcy cycle, the likelihood that the tax burden increases, and also on the path of inflation. On the latter, governments have the desire to generate it to deal with the debt burden, and also new fiscal tools with which to address that. All these sound like issues that true believers in cryptos would point to as a reason to hold them, but one does not need to be an arch-libertarian to make the case that policy shifts in these directions, make a case for holding fiat currencies, as long as one is comfortable with the idea that the supply is limited for only practical purposes.

Two products of the 17th century seem relevant here. The Treaty of Westphalia is traditionally taken as the starting point for the acceptance that sovereign states are the basic unit, for international law. Later that century also saw the foundation of the Bank of England as part of an attempt to finance the Royal Navy, but by so doing generated the idea of a central bank with monopoly on issuing money, which would then be acceptable for the payment of taxes. If cryptocurrencies become much larger than they are today, they implicitly threaten both these types of 17th century creations. The attractions of crypto are also what make them potentially an annoyance for policymakers. Cryptos do have a place in asset allocation for as long as they are legal.

Okay, so just a couple follow-ups. One really interesting note, very outside the norm of your traditional investment or research note. I think Inigo really let themselves go a little bit in the back end, which I appreciate, I think is really cool. Second, I think it's interesting to see how much this note kind of dismisses Bitcoin's solo nature and asks whether you can make an argument for limited supply even beyond that. I don't want to get right here into the merits of that or not. I more just want to flag it as interesting, specifically because they come away as saying that there is a limited supply for all practical purposes. I think there's a lot of people who would rightly point to Bitcoin specifically as having the network effect that makes that a less relevant question. But the flip side is,

if you see tons of institutional investors eventually diversify their way into everything else, Maybe this is a useful heuristic as well. Third, I think it's really interesting that it is very clear that the sovereign threat is emerging as the biggest source of potential long-term skepticism for this asset category. It keeps coming up on Twitter. We talked about it yesterday, and it's here again. And it's interesting that because these institutions aren't recommending that you don't get in because of that, although some like Dallio are. but it's just fascinating to see how much that is where the fud is heading. Clearly some interesting food for thought.

With that, guys, however, I hope you enjoyed this piece. And until tomorrow, be safe and take care of each other. Peace.